Finding the new model army

Some say the best innovation begins with the business structure itself. Martin Cowen examines how companies can look at new models to gain competitive advantage.

Writers of a certain age still reserve a soft spot for the offline world – that doesn’t mean we go into high-street travel agents to pick up a brochure, but there’s still a place for making notes in a book. With a pen.

IBM emerged as an abbreviation for ‘innovative business models’ during the preparatory scrawls for this piece.

The acronym also emerged top of natural search when I gave Google a go, as the accepted name for International Business Machines Corporation. No surprise that the $100 billion-plus IT-based business has its site so well optimised.

This April, IBM’s Global Business Services unit released a white paper – Paths to Success – which identified three types of business model innovation across sectors: industry models, revenue models and enterprise models (see box below).

Its top-line conclusion: business model innovation has a much stronger correlation with operating margin growth than other types of innovation, and that there is no significant variation in the financial performance across the different types of business model innovation.

The report was co-authored by Saul Berman, who runs the strategy and change practice within IBM’s Global Business Services. He told Travolution that in the current climate, “this is a great time for businesses to exploit their growth potential and accelerate the rate of business model innovation”.

While IBM’s cross-sector study didn’t look specifically at any online travel agencies, Berman says that “innovation is easier for digitised businesses because they are not dealing with physical products”. Google is a strong example of industry model innovation – it created its own industry. Its physical assets such as the Googleplex and its servers are minimal. And there are plenty of digitised businesses in the travel space.

David Soskin, former CEO of Cheapflights and co-founder of investment house Howzat Media, agrees with Berman. He says: “My own view is that digital is a radical medium. It is cheap to produce, which is bringing technology costs down. And you can change the model and test it without killing the golden goose.”

One of Howzat’s investments is in community site WAYN. The model has changed so often it needs a new name, but its golden goose is the traffic it has built up. What started out as a subscription-based service dropped the joining fee and ended up with 15 million members. It realised that its members were not travelling as often as they went to the pub, so its latest incarnation is a travel and lifestyle social networking community.

Quite a busy five years since it first secured funding.

Compare this flexibility with the vertically integrated tour operators. Paths To Success observed that the business model innovation most preferred by older businesses is enterprise innovation, namely “focusing on partnerships and collaboration”. However, the difficulty with this type of innovation is that “more than half of all strategic partnerships fail”.

Berman explains: “Businesses need to collaborate better, both internally and externally. Partnerships tend to work better when there is a culture of co-operation within the business.”

TUI and Thomas Cook are not averse to the occasional strategic partnership, but their innovation lies in optimising what is an established business model. It’s also quite successful – their annual profits are impressive for an industry where a margin of 5% is the norm.

However, one key part of their model is the interest they earn on the cash. With UK interest rates at an all-time low, and consumers booking closer to departure, this revenue gap needs to be closed. Chris Lee, who deals with £20 million to £70 million turnover travel businesses as head of travel at Barclays, says: “Some businesses earned as much from their interest as they did from their travel business.”

Innovating the model in order to generate cash is a risky business, because it should already be factored in. “Cash is king, always has been,” says Lee. “Running out of cash is one of the main reasons a business goes bust. The current climate just reinforces this.”

One of the many vagaries of the UK travel business is the acceptance that for much of the year it will operate at a loss. Tour operators and airlines are particularly exposed to this, and if ever an industry was in need of innovating its business model, it’s the airline sector.

Soundbites abound about how the industry has lost more money in its history than it has made, or that the best way to become a millionaire is to start off with a billion and launch an airline. At the last count, IATA reckons the industry will end this year with a net loss of $4.9 billion.

But it’s not through want of trying – there have been a lot of innovations within the sector. Unfortunately, no one from Silverjet, Eos or MaxJet was available to discuss the success of their attempts to offer a business-class-only transatlantic service.

It’s also worth remembering that low-cost transatlantic flights have tried and failed. Sir Freddie Laker’s SkyTrain was truly innovative when he set the ball rolling in 1971. The first flight didn’t take off until six years later, and the airline went bust in 1982.

And to complete the rogues gallery, US carrier People Express – the first airline to charge for baggage checked into the hold – went bust after six years in business. This happened nearly 20 years ago. As Berman points out: “The airline industry was an early advocate of different pricing for different consumers, and led the way in terms of revenue and yield management practices.”

Someone somewhere will try to launch a UK-based business-class-only carrier, while low-cost transatlantic flights remain a possibility – Ryanair’s Michael O’Leary threatened to launch one a few years ago but nothing concrete has materialised. But the experience of People Express hasn’t deterred airlines from trying to charge for peanuts and priority boarding. Airlines will be able to innovate their revenue streams, if not their industry model, by taking advantage of the tools available to facilitate the sale of flight-related extras.

The travel technology businesses, formerly known as GDSs, are active in this area, but there are also off-the-shelf tools such Navitaire’s New Skies and Open Skies platform, used by most of the leading low-costs carriers and independent of the GDSs.

One of the 35 case studies in Paths To Success looked at Southwest Airlines, the original US low-cost carrier, although it still gives out peanuts for free. It was credited with having innovated its revenue, enterprise and industry model. Ryanair would sit comfortably with the revenue innovators.

At the Travolution Summit in April, Amadeus group vice-president Gillian Gibson told delegates that the technology provider was working on products that would help airlines “retail” their product rather than “distribute” seats. It is convinced that all airlines will adopt a menu-pricing approach, despite its own research that shows a mixed response from consumers. It found that in the US, one-third of fliers actively disliked having to pay for extras while half “disliked it but understood why airlines were doing so”. Only 12% liked having the option.

Berman suggests “business model innovation can change consumer behaviour,” while at the same time acknowledging that the airline industry’s move towards menu pricing was “driven by economic necessity”. If menu pricing becomes the default option for airlines – Amadeus thinks it will – then consumers will have to pack less or bring a packed lunch if they want a better price.

And there is scope for innovation within the innovation. Henry Harteveldt, travel analyst at Forrester, said: “We may also see revenue-management models applied to some ancillary products – for example, the checked baggage fee may be less on shorter flights, more for longer journeys.”

There are direct and indirect costs to consider in all aspects of business model innovation – Amadeus will not let airlines use its tools for nothing. And in the current climate, all costs are being scrutinised.

Berman however, remains convinced that “there needs to be a focus on the core business activities with an emphasis on preserving cash, but now is the time to rethink...If your business is struggling at the moment, this should be a prompt to innovate, because if the current model isn’t working, what is the choice?”

Cynics might argue that a struggling business at least has a choice about innovation – unlike businesses trying to get off the ground. Soskin presented a bleak picture of the state of funding, particularly within the UK. “Venture capitalists are having a torrid time. Forget about bank lending – they’re not lending to blue-chip businesses, never mind early-stage technology start-ups. Angel investors have been clobbered by tax increases and stealth taxes, so that important source of funding for start-ups has been absolutely smashed to pieces.”

The end result is that “the tolerance of investors to take their time while the model proves itself has gone. Monetisation is the name of the game.”

Monetisation is also something Berman sees as part of the innovation landscape. His specialism is media and entertainment, a sector that has changed as a result of the internet as much as travel.

When Apple started delivering music direct to consumers via iTunes, it was merely legitimising what the ‘illegal’ file-sharing websites had been doing for years. It was “monetising the enabling behaviours the customer would prefer to use” in the way that the online travel agencies are looking to profit from the traffic they get from users searching rather than shopping.

When it comes to traditional travel businesses, the established business model was forced to change when the online travel agencies entered the market. Similarly, the OTAs were forced to look for non-transaction revenues in response to supplier direct, disloyal shoppers, a saturated market-place and the resurgence of the aforementioned traditional businesses. So while many innovations arose out of necessity, proactive and successful innovations are rare.

When it comes to travel, the established business model has been changed dramatically since the online travel agencies entered the market. While many innovated reactively to cope with the new business landscape, truly innovative business models are rare to find. French tour operator Club Med had an innovative business model when it launched in 1950 – it was a not-for-profit organisation. There will be quite a lot of travel businesses, innovators or not, that will end this year in a similar position.

Is free really the answer?

Chris Anderson identified an innovative business model back in 2004 when he realised that the internet could help specialist businesses find customers at a manageable acquisition cost. Hence, “the long tail” entered the financial and travel vernacular.

His next book will be out this July. Free – The Past and Future of a Radical Price will, according to the publisher, argue that “businesses can profit more from giving things away than they can by charging for them”.

Within the travel sector, there are examples of this, although usually as a marketing gimmick.

No-one really falls for buy-one-get-one-free anymore, but Las Vegas hotels for example often reserve rooms for high rollers, working on the idea that they’ll more than make it up on the casino floor, never mind the sorrows-drowning mini-bar bill.

The shrinking cost of hardware has also made gadgets affordable, from the PC through to digital cameras. Mobile phone companies are able to offer the latest smart phone ‘free’ and make their money from the associated contract. But these free tools are being used by consumers to drive other businesses.

TripAdvisor is a reviews site, which doesn’t pay its reviewers, and the reviewers have all the tools available – as well as the 15 million text-based reviews on the site, there are also millions of photos and images.

If digital cameras, PCs and the cost of running a website that has 20 million unique users a month hadn’t trended towards free, would the TripAdvisor model work?